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A Roth conversion could be a silver lining in a down market.

By Jim Mahaney, Vice President, Strategic Initiatives

March 20, 2020

The dramatic downturn in the financial markets spurred by concerns about COVID-19 is reminiscent of the Great Recession of 2008. But we’ve learned some lessons since then. Those close to retirement and watching their IRA or 401(k) values drop may have a silver lining.

There is a way to make up ground without trying to time the stock market and “buy low.” Converting your traditional IRA to a Roth IRA, or converting all or part of your 401(k) to a Roth (called an in-plan conversion), could be a solution, and one with significant tax benefits. With either option, when you convert to a Roth, you will pay taxes in the current year, since you’re working with pre-tax savings and you are realizing your investment gains in 2020. That may be a near-term hit, but the payoff is that you won’t pay taxes on all your withdrawals in retirement.

And by converting now, when account values are lower, you might realize significant tax savings over your lifetime. In addition, all future investment growth on the Roth assets will escape taxation.

With a traditional IRA, you can convert all of it or just a portion. If allowed under your plan, you may be able to convert a portion or the entire balance of your 401(k). Another advantage is that a distribution from a Roth 401(k) is tax-free and penalty-free if it has been five years since the initial Roth contribution and you are at least age 59½.

Having tax-free income in retirement is attractive on its own. But the real benefit of having both Roth and traditional pre-tax accounts to pull from in retirement is the ability to minimize the impact of taxes by withdrawing up to the top of a specific tax bracket each year. In addition, you may be able to time your withdrawals to keep your Social Security benefits from being taxed and/or keep your income low enough to minimize your Medicare premiums.

But a conversion might not be an answer for everyone. There are some disadvantages. By converting now, your account value might actually decline further between now and retirement and you will have paid taxes on a converted Roth value you never took into retirement. In addition, even if your account grows, you could find yourself in a much lower tax bracket in retirement. Consultation with a tax advisor can help.

What matters each year of retirement is having the right amount of after-tax income in your pocket. By converting some of your pre-tax IRA or 401(k) assets now, the amount you need to ultimately save for retirement is reduced since a portion of your taxes have been prepaid.

While a Roth is not for everyone, for some, it may be a silver lining in a down market.


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This material is being provided for informational or educational purposes only and does not consider the investment objectives or financial situation of any client or prospective clients. The information is not intended as investment advice and is not a recommendation about managing or investing your retirement savings. If you would like information about your particular investment needs, please contact a financial professional.